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The Conundrum of Donor-Advised Funds

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Donor-advised funds have been the fastest-growing charitable vehicles in recent years, but many of their advantages are still underused and underappreciated.

With these charitable accounts, you can make a big contribution, take a deduction for the full value of the contribution, invest the assets, and take time to decide how to distribute the gifts to charitable organizations in future years. 

Critics point out these accounts stall the distribution of donations to nonprofits that could desperately use it. Some of the largest DAFs have contribution requirements, but they aren’t stringent: Fidelity Charitable requires donors to gift at least once every two years; Vanguard Charitable requires at least a $500 gift be gifted every three years.

The sweet upfront tax deduction and simplicity—the fund takes care of administration and record-keeping—have fueled massive interest, driving assets in DAFs to $160 billion in 2020 from $145 billion in 2019. And there are more reasons to like DAFs.

“The original interest has been as convenient pass-throughs to charity that help people track all of their gifts from one place,” says Gretchen Hollstein, a senior advisor at Litman Gregory in San Francisco. “But there are a lot more tax and estate-planning reasons high-net-worth individuals

and families are starting to use DAFs.”

Higher Deductions, More Privacy

Consider the tax advantages of DAFs compared with private family foundations, which are the traditional charitable vehicle used by high-net-worth families. Tax deductions for cash gifts to DAFs are capped at 60% of adjusted gross income under tax law. For foundations, the deduction is capped at 30%. 

For investors who give appreciated stock to their DAF, the value of a deduction is capped at 30% of adjusted gross income with DAFs and 20% with foundations. What’s more, DAFs have privacy benefits: The recipients and size of your gifts from a DAF remain private, while gifts from a private foundation are public record.

Contribute Illiquid Assets With Ease

Wealthy donors can minimize taxes and leave more to charity by donating illiquid assets to a DAF, rather than selling the assets, paying the capital-gains taxes, and donating the after-tax proceeds, says
Dien Yuen,
executive director of the Center for Philanthropy and Social Impact at the American College of Financial Services.

“It can be an oil field, a coal mine, a parking lot, crypto, or a complicated business, you can make a gift through a DAF. The larger DAFs will put a team on it to assess and liquidate the asset,” Yuen says. “You can do the same through a private foundation, but the tax deductibility will be less.” 

Not all DAFs have the expertise to accept complex assets, which must go through a vetting process to ensure they can be liquidated within weeks or months and there are no legal issues.

At Fidelity Charitable, two-thirds of donations are noncash assets, “and we see donors being more strategic. Last year, 11% of what we took in was in the form of nonpublicly traded assets such as closely held business interests, cryptocurrency, and certain types of commercial real estate,” says Colby Bircher, Fidelity Charitable’s vice president of charitable planning.

Add an ESG or Impact Component

Many DAFs have been adding ESG investment options, and several DAFs with impact missions have cropped up, enabling donors to invest underlying assets for impact until they are eventually distributed to charities.

“We recognized there was an underutilized platform around how DAFs are constructed—there’s capital waiting to be granted, but given standard investments offered in DAFs, it wasn’t being aligned with donors’ values,” says Amy Bennett, chief marketing officer at ImpactAssets, a Bethesda, Md., impact investing firm. 

ImpactAssets runs a DAF with an impact investment platform. The fund offers a range of impact options from mutual funds to longer-term illiquid private investments. Among investments are Generate Capital, a San Francisco-based company that finances sustainable infrastructure. Another is Replate, an Oakland, Calif., nonprofit that connects surplus food sources with communities in need. 

“Wealthy people are dynamic in their approach to giving,” Bennett says. “We believe the capital they are investing in a DAF can complement that.”  

This article appears in the December 2022 issue of Penta magazine.

Credit: marketwatch.com

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